Over taxation of one-off pension payments major issue in cost of living crisis

Lisa Webster

Lisa Webster

The cost of living crisis is giving us daily headlines and daily headaches, not least for the new prime minister and chancellor as they try to help people while also dealing with the deficit.

As those in need reach age 55, more and more of them may be pushed towards accessing their pension at an earlier point than planned. With energy bills to pay and food prices rising faster than we have seen in decades, some will feel they have little choice. 

However, those that access benefits for the first time might be in for another nasty shock. The over taxation of one-off pension payments is still a major issue, and the unadvised may not be prepared. 

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The latest pension flexibility statistics released in October’s Pension Scheme Newsletter show that 9,956 reclaims were processed in the period June 1 to September 30 of this year, with more than £33mn in overpaid tax returned to taxpayers.

Since pension freedoms were introduced in April 2015, there has now been £925mn of in-year repayments. 

The actual figure for repayments will be well in excess of £1bn when you consider that those who wait until the end of the tax year for HMRC to rectify the situation via the P800 are not included. 

The issue arises as these payments must be taxed on a ‘month one’ basis – as if they were going to be received every month in the tax year (regardless of which month actually paid). This means only one-twelfth of the personal allowance and each tax band is available for each payment. 

When we see headlines about one in four people having less than £100 in savings? How can it be right that HMRC insist that tax is automatically deducted in cases when it is known it is not due?    

We would like to see a more pragmatic approach from HMRC, so where the member has made it clear to their administrator that they only intend to take a one-off payment in the tax year a ‘month 12’ tax basis can be used. This effectively gives the whole personal allowance for the payment, and the full tax bands after that.

Yes, there is a risk that if the member changes their mind and they need to take a subsequent payment in the year then they would face higher tax charges on these later payments, but warnings could be given when the first payment was made, and these cases would be the exception.

Bear in mind that even if you take the one-off payment on April 5 the current system will still overtax. 

Surely a month 12 basis has got to be better than deducting undue tax on those that need the money the most?